Human beings are the creatures of habit. Traders have the habit of sticking to the same plan even when it is not giving them the desired result. However, some habits are worthy of breaking in order to achieve your goal. One needs to be very careful while trading in options. The options traders tend to make the same mistakes repeatedly. But these mistakes could be easily avoided. Below mentioned are few mistakes one should avoid to be successful in trading options.

Mistakes to avoid

Not deciding on exit plan- While you are trading with options, you need to have a great control over the emotions. You need to have a plan chalked out before you begin trading. No matter what happens and what your emotions are, you need to stick to the plan and should not deviate from it. Planning the exit point is very much essential for you as it not only helps in minimizing the loss when the things are going bad but also helps when the trade is going good and in your way too. You should choose the upside exit point too in advance along with the downside exit point.

Other than choosing the exit point, in the case of options, it is also important to decide on the timeframe for the exit.

Making up the earlier losses by adopting doubling up strategy- In the case of options, doubling up never works for the trader. Options are derivatives and their prices do not change like the underlying stock price. Doubling up will only compound the risk. It is best if you accept the loss and move on instead of building something for a bigger catastrophe.

Taking too much time to buy back the short strategies- You should be always willing and ready to buy back the short strategies much early. People make the mistake of believing that the trade will continue to be the same when it is going in your way, but it won’t be so in all the cases. Any time the trade can just turn around the other way.

Trading the illiquid options- Whenever the trader get the quote for the option, there would a difference between asking price and bid price. Mostly, ask price and bid price do not reflect the options that are actually worth. The actual value of the options will be in the middle of ask and bid price. How far the asking price and the bid price deviates is depended on the liquidity of the option. The spread between these two prices is narrower in case of options which have high liquidity.

Illiquidity in options is more serious as you will be dealing with the illiquid stocks. Since the stock is inactive, the options will be more inactive. Ask and bid price spread will be much wider. Hence you need to keep away from trading on these options and choose only to trade the highly liquid stocks.

Yes, you read that right. Many studies keep coming up with new figures and statistics about the effect of inflation on the economy and societies. It can be both negative or positive in most of the cases. At times it helps the economy to recover from the recession and that is the amazing contradictory aspect of this phenomenon.

Of course, if inflation is too high then the economy and the society or the country may go through tough times. But when inflation is controlled by the government and is not allowed to go beyond a reasonable rate, then it can help the society to prosper. It may, in fact, lead to more employment and more money in circulation and this positive outlook may help the economy to improve and grow.

Distribution of wealth changes with inflation

If the rates of interest go down then the people dependent on their savings, like retired citizens will obviously lose money and this may lead to an unequal distribution of money within the system. The real income of people may stay at the same level for a long time. With fewer incentives and encouragement savings also go down. All in all, inflation may make some people rich and others remain poor.

The country may suffer an economic burden

If one country has more inflation than others, then it will lose money by exporting or importing goods from other countries. This, in turn, further corrodes the value of its currency and GDP of this country goes down too. Moreover, reduced orders and consequent pay reductions and fewer jobs may harm the economy of the country suffering from a higher rate of interest.

Deflation is bad too

Many studies and even the past experiences have shown that deflation is bad too for any economy. The rate of inflation is calculated using the consumer price index. Deflation or hyperinflation, both have a negative impact on the purchasing power of people and the rates of lending and borrowing. These affect the economic recovery process.

If the government is in control of the situation and they can predict or plan at least a couple of years of future policies, then it will help people to plan their spending and investing. If the rate of inflation is controlled, then they can turn around the economy and make it worthwhile for everyone. Companies and individuals both can plan their strategies based on the state of the economy. The expansion, borrowing, spending and investing are all decisions based on the economic policies and established on rates of inflation.A controlled rate of inflation governed carefully by the state authorities will help to put the economy back on track.

Every company or every asset that you invest into comes with the market and systematic risks. This could be because of inflation or changes in interest rates or even a war. The risk is not specific to any company. This can be minimized when one diversifies his portfolio.

Risk management can be achieved by diversification. Companies spread their own risk by selling many kinds of products and also selling globally. This lets them manage risks. Similarly, an investor can also manage his risks by diversifying his portfolio. When an investor diversifies his portfolio then a specific risk that is related to a particular asset gets offset by the risk of another asset.

Why should you diversify your portfolio to manage risks?

Diversification is not to boost the performance of your portfolio. It does not guarantee you any sort of gains or ensures you that there will be no loses. However if you have chosen the risk level based on what your goals are as well as your time horizon and what your tolerance to risk is, diversification can actually help to improve your portfolio and let you manage risks.

So in order to do risk management and to diversify your portfolio, it is important that your portfolio has a mix of stocks, cash, bonds, and other instruments. These are important because if you look closely then all these assets do not necessarily move in the same direction. You should also aim to have those assets which move in opposite directions. This will balance out in case a part of your portfolio is declining then there is another part that is making up for these losses.

Thus diversification lets you offset some of the losses.

Also, make sure that you do not over concentrate your portfolio with a single stock. If you are investing in stocks then you should diversify your portfolio into small, medium and large-cap stocks. The diversification should also be based on sectors. This is important because not all sectors or all geographies would move in the same degree and this lets you reduce the risk on your portfolio and also lets you spread your portfolio.

When you chose to invest in bonds then you need to have a portfolio that has invested in various maturities and durations. This will measure any sensitivity to the interest rate changes that impact the bond prices.

Diversification and risk management

When you manage risks you basically look to control the amount of money that you can afford to lose. As a smart investor, you thus should make sure to have a diversified portfolio and not put all your eggs in one basket. If you do not diversify then chances are that in case the stock or the sector that you invest into has some bad news then it could make you lose all your capital.

One of the most discussed and difficult financial concepts as far as a small business owner has to understand and consider is the working capital. The term is often interpreted in different ways sometimes which could be demystifying, as the way to depict it in general terms differs in a matter of understanding it in principle. The business runs in the calculations on how in each period to analyze the working capital and how to meet them on a regular basis.

What is Operating Cycle

The operating cycle is useful in analyzing the accounts receivable, inventory, and accounts payable cycle in terms of days. The receivables are analyzed in terms of the needs of the business in terms of days; the inventory is calculated as the average number of days it takes to convert into a sale and the payable which is analyzed in terms of the number of days it takes to pay a supplier.

Many businesses cannot meet their financial requirements with the existing operating cycle with the receivables and payables alone; hence they may externally borrow or try to cover the shortfall with the profits generated.The requirement of short-term capital could arise due to seasonal nature of the business or a good demand for the products in the market due to the holiday season. Planning to fund in the short term requirement is essential to get an increased production and profitability, without getting caught off guard.

Sources of financing in Short term

Equity- borrowing form a third party, family or friend is a way out to meet the immediate fund requirements if the business is yet to make profits.

Creditors- sometimes the creditors extend their credit facilities in terms of a good and harmonious relation, to increase the credit period from the 30 days to a 60 days period to fulfill a big order, with or without a lien.

Short term loan-usually a one-time loan can be availed from banks to fund in to meet the working capital requirements to complete bulk and huge orders.

The line of Credit-this is usually availed by big businesses when they have a spread over the year with each loan taken once in 30-60 days period as and when the working capital requirement arises, with repayments start happening once the receivables are collected

Factoring is another way to meet the financial requirements of a business in the short term when the receivables are brought in by the financial institutions and all the sales amount collected are taken by the factoring finance company, which could be an expensive way out due to the high lending rates.

Procuring the funds to meet the requirements in the short term could be eased out if there is an efficient way to handle the cash conversion cycle and keep funds aside for business contingencies and expansion.

We all read futuristic science fiction books and see many movies about the future of mankind. They always depict artificial intelligence and robots and time travel. But now a real futuristic concept has actually revolutionized the present financial world. It is almost as if a space-age currency has come back in time.

Do not be apprehensive

It is a concept that can be explained but yet people find it difficult to understand and use and many countries are yet to create a system that can accept this kind of currency. Due to lack of awareness and understanding, many countries with stronger currencies are clamping down on this futuristic technology as well. This is known as the blockchain technology. This system is the basic foundation of all the digital currencies so far. People in the software industry were the first to start creating this, using their super powerful computers. Now many online services are ready to accept these currencies as payment in lieu of services or goods.

What is the technology

The blockchain is a simple, sincere effort of some software professionals to create a record of every financial transaction that takes place. This creates an open document that can be seen by anyone and it is in public domain. It is complex and people may not access it due to unawareness but it is not a secret or hidden record. It can be understood easily if you visualize a document, that has many transactions recorded across the world. All the transactions are recorded and are always open to everyone. So this data keeps replicating in the records in everyone’s document.

Who governs this currency

It is completely decentralized. That means it is the internet community that keeps a record of this blockchain and money that transfers hands, but no one can control it. It is not minted like paper or metal currency. No government or authority actually controls the mining of information or these currencies. Blockchains can keep increasing in size as these are replicating on increasingly more computers but the number of coins was kept at a fixed number. There are many blockchain currencies launched by various groups but some of them failed to take off. Some are really doing well and well respected, like Bitcoin and Ethereum.

The value of these coins is dynamic and people hear of many rumors about these being banned in certain countries. The fact of the matter is that as the government authorities cannot understand how to control their use or mining, therefore they try to throttle their use in their countries. However, these currencies, at least some of them are readily acceptable and traded online. You can use them once you understand the concept and are comfortable with the anonymity connected with the same.

The financial market has become very successful in the last few years with the evolution of technology and its inputs.There is also the need for the risk management techniques and they have been also well placed for the smooth functioning of the financial sector as a whole.

The stock market trading and also its day-to-day deals have become more in number and also very unique in their functioning. All this calls for the strategies which are effective to deal with these stock changes at a larger level. In order to swim across the tide times in the investment sector, we have the basic two modules to help us. They are Hedging and Arbitrage functions. These two play an essential role in managing investment risk to a great detail.

Role of Hedging:

Meaning and concept– hedging is the use of financial instruments to reduce the effect of investment risk with help of another investment. Investors hedge by procuring two securities that are negatively correlated, thus providing the risk from price changes in the volatile market.

It is not a risk-free trade but a trade with minor risk in it. This makes complete sense of satisfaction for traders to trade. Some of the common methods are option contracts, forward contracts, futures contracts, swaps, and derivatives. These are used to for betting against the upward as well as the downward movements in the market and help the hedger to experience minimal loss.

Hedging is essential in the financial market, gambling and business management though it can be used anywhere for risk aversion. Therefore by actively using the derivatives, the hedging function reduces the potential loss which traders may face.

Role of Arbitrage:

Meaning and concept: Arbitrage is a method of simultaneously investing in securities to prevent the loss of money during price fluctuations in the stock market. More clearly to explain, it is buying a security in one market and investing it in another market to be free of the price changes in both markets affecting the investment.

Arbitrage ensures that price doesn’t change a long way from their fair value at which it can be traded easily. This has also been a solution to eliminate risk in automate trading setups too and has helped the investors to keep monitoring which stock to buy and sell simultaneously.

There are many types of arbitrage functions to suit the different price movements in the market.

Now that the clear difference has been understood, trading in such markets which are risk-prone becomes easy with help of hedge and arbitrage functions.

Hedging is often understood as insurance against risks. Hedging does mean insurance against any untoward incidents in the financial market, but it is not as simple as getting protection against negative impacts by just paying a premium.

How is hedging different from insurance?

In layman, language Hedging is definitely meant insurance against losses one might have to face while dealing in financial instruments. If we look at the nuances of hedging in the financial market, it is a lot more complicated than insurance. The process of insurance is less time consuming and a lot easier.

For instance fire insurance. We just need to find the right policy and pay the premium periodically. This will take care of protections against any fire accidents on the assets we have insured.

Hedging is lot more complex task. In the financial market that is ever evolving and highly volatile, the investor needs protection against any potential losses caused by price fluctuations of the securities. The impact of the adverse price changes of the investments can be reduced through various hedging techniques. It is essentially managing the risks by picking the right mix of financial instruments that offset the loss caused by the price fluctuations.

Hedging – Is it a perfect science?

Hedging is performed with the help of complex financial instruments called derivatives. Derivative, as the name suggests, derives its value from another commodity or underlying asset. For example – A trader dealing with corn is worried about the increase in corn prices. He can enter into a forward contract to buy corn at a specific price in future. In the event of price rise, he is unaffected by it as he can buy it at the strike price agreed upon. But in case the price falls he will still have to buy corn at the strike price itself. The success of the hedge is not guaranteed. It only helps in offsetting the risk but does not guarantee a profit. It does not qualify to be a perfect science due to the unpredictability involved in the success of hedges.

Hedging in the financial scenario is usually performed by selecting two financial instruments which have an inverse relationship. The investors will have to select the investments strategically to be able to benefit from the hedging proposal.

Who performs the task of hedging?

One needs to understand the nitty-gritty’s of the various financial instruments to perform hedging. Individual investors are less likely to perform this as they might not necessarily be worried about the short-term price fluctuations. It requires the skill of an investment manager who has a fair amount of experience dealing with various financial instruments. Even though the task of hedging is best done by the professionals in this field, it is important that the investors have some idea of this complex process.

Hedging also comes with a cost. It will definitely eat into the investor’s profits. The investor needs to decide if he needs more profit or protection against any contingent losses.

How much is the risk involved? Becomes the primary question in any means of trade or business, where the exchange of goods or services is as important as to the risk involved in such trading. Today, when companies are engaged in multimodal activities and are into various segments of the business, one of the essential assumptions would be how much risk to be taken and gain maximum returns on the capital invested. Let’s take a quick look at roles of hedging in reducing the risk and safeguarding the LTC among different businesses.

Protects the value in the business

Business houses which greatly deal in foreign exchange, import and export of foreign stock face a steep increase/ decrease in the exchange rates of currencies. Since they operate with different countries the ever-changing rise and fall of currency rates affect their operations in large. Currency hedging mitigates the uncontrollable and unforeseen risks of the trader or investor. Assuming if that Taurus Company which is a multimodal company based in India invested in Canadian market which was an appreciating market would be in an advantageous scenario due to the increased currency value in the market investing.

Hedging tries to fix prices of commodities

Farmers and other base level manufacturers use the hedging to come over the inefficiencies at the prices of their commodities they manufacture. Base level manufacturers like textile, steel, a farmer etc, invest in a huge quantity of raw materials and expect a certain price for the commodity manufactured have to secure the prices against the tremendous fluctuation of prices. To safeguard against the risk they hedge against the future price of the commodity on a contractual agreement with the retailer on fixed premiums. So he is protected against the increase/ decrease prices if the commodities.

Equity market risk can be reduced

The main essence of an Equity market is the high time volatility. Steep increase/ decrease in the prices of the stocks at regular intervals can make can make or break an individual’s portfolio. Hedging is a kind of insurance which u take against the risk of falling markets. It can be held for a particular moment of stock that is when you expect the markets to be on particular momentum and how your invested stock reacts to that momentum. Hence hedging creates an impact on the returns on investment.